Are the IRS’ Financial Statements in Good Order?

By George W. Connelly

Anyone who has been through an IRS examination knows that the principal focus is often on the Taxpayer’s “records,” and whether they are complete and accurate.  If they are not, a victim runs the risk that the IRS will propose additional tax liabilities with respect to expenses that are not proven to the satisfaction of the IRS auditor, that various receipts which may come from inactive sources are treated as income, that a 20% negligence penalty will be applied on top of the tax, and that the IRS auditor will deliver to the taxpayer an “inadequate records notice.”  It is important for a business to know exactly where it has been, as well as where it is, and those reasons alone should be enough to warrant keeping complete and accurate records, but the possibility of IRS adverse action offers several more.

Given this IRS’ fixation on the quality of taxpayer’s records, how good do you think the IRS’ own records of its activities are?  Would you assume that they are every bit as good as they expect a taxpayer’s records to be?  The answer is “not exactly.”

In November, 2010, the General Accounting Office issued a report relative to its “financial audit” of IRS fiscal years 2009 and 2010.  The GAO is an arm of Congress and, much like TIGTA (discussed in a prior article), periodically audits the IRS.  Here’s what the GAO had to say:

“In GAO’s opinion, IRS’ fiscal years is 2010 and 2009 financial statements are fairly represented in all material respects.  However, serious internal control and financial management systems deficiencies continued to make it necessary for IRS to use resource-intensive compensating processes to prepare its balance sheet.  Because of these and other deficiencies, IRS did not, in GAO’s opinion, maintain effective internal control over financial reporting as of September 30, 2010, and thus did not provide reasonable assurance that losses and misstatements material to the financial statements would be prevented or detected and corrected timely.

In particular, the GAO cited the following “deficiencies”:  Material weaknesses in the internal control over unpaid tax assessments and information security; non-compliance with the law concerning the timely release of tax liens; and financial management system’s substantial non-compliance with the requirements of the Federal Financial Management Improvement Act of 1996.  GAO went on to note that the IRS continues to rely on financial management systems that “do not substantially comply with FFMIA requirements, affecting the IRS ability to produce reliable financial statements and to make well-informed decisions.”

If you were a taxpayer and audited by the IRS, you can only imagine what problems you might face if your own accounting system had comparable discrepancies.  What sanctions do you think the IRS faces as a result of them?

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